What happened
Shares of leading ethanol producer and distributor Pacific Ethanol (ALTO 3.17%) fell more than 13% last month despite the company reporting growth on multiple fronts during the first quarter of the year. In Q1, revenue and gallons sold increased 13% and 9%, respectively, over the year-ago period. That nudged shares up in the beginning of May, but shares resumed their year-to-date slide shortly after that, ending the month at a new low for 2017.
The cause for the stock's slide seems to be simple: political uncertainty and drama. While that isn't an unfamiliar driver of volatility among biofuels stocks, several policy proposals from the new presidential administration represent sharp departures from the status quo that has existed since the Renewable Fuel Standard (RFS) went into place in the mid-2000s. The industry is scrambling to keep up, but Wall Street doesn't seem to be willing to stick around to see how things play out.
Image source: Getty Images.
So what
The year began on a sour note for ethanol producers. Five major pieces of legislation were introduced that sought to significantly reduce -- or scrap entirely -- the volume of biofuels that must be produced each year under the RFS. At least one was likely nothing more than a political stunt, but the message was clear: Change could be coming.
The drama continued in May. On the same day that Pacific Ethanol announced first-quarter 2017 earnings, several senators sent a letter to the U.S. Securities and Exchange Commission urging an investigation into trades made by billionaire Carl Icahn in late 2016 betting that the price of renewable identification numbers, or RINs, would drop. (RINs are the tax credits used to track ethanol blending in gasoline and ensure that petroleum refiners comply with the RFS.)
Icahn allegedly made a $50 million profit from his trades against RIN prices, which came after helping anti-RFS advocate Scott Pruitt assume the top spot at the U.S. Environmental Protection Agency and consulting the White House on legal arguments to weaken the RFS. RIN prices fell 20% and 17%, respectively, on each news event.
At the end of May, the White House released its budget proposal for fiscal year 2018, which begins in September 2017. It included billions of dollars in funding cuts to various programs that support farmers, agriculture, and the RFS. It's unlikely to go into effect without major changes in Congress, however, especially given broad support for farmer subsidies across the political aisle.
Additionally, a lack of diversification in Pacific Ethanol's business also appears to be playing a role in its stock's performance. Whereas other leading ethanol producers have built revenue streams outside of biofuels in recent years -- Green Plains now produces food-grade vinegar and cattle feed in addition to ethanol-- Pacific Ethanol has remained focused on ethanol production and distribution. Thus, it remains less insulated from volatility than some of its peers.
Now what
Most of the volatility for Pacific Ethanol stock in May -- and in 2017 -- appears to be due to knee-jerk reactions from Mr. Market. Investors should know that it's highly unlikely that the RFS would cease to exist anytime soon. Many moves considered by legislation introduced in Congress seek only to cap mandated production volumes. Since the U.S. market is oversaturated, this wouldn't have that large of an impact. Ethanol producers are also exporting record amounts of fuel each month -- with no signs of slowing -- which would seem to be an important card to play with the current administration.
Value and growth investors alike can still find plenty to like about Pacific Ethanol stock for the long term.
